Home Ownership and Wealth Building

Most wealth accumulation happens rapidly and late in life — after the kids leave, when income is high, debts drop, 401(k) accounts fatten and home equity swells, according to Fed data.

The safety net — Social Security, pensions and Medicare — also has resulted in big increases in income for the elderly and a sharp decline in the rate at which they dissipate their assets in old age. Most people over 60 have no mortgage debt, no credit card debt and no car loan.

Trends for younger people have gone in the opposite direction. Mortgage debt peaks for people in their late 30s, the same time they have the most kids at home. About 11% are at least 60 days behind paying on some debt.

Younger generations now delay the start of wealth accumulation. They postpone careers to get more education. They marry later (delaying the financial benefit of a shared household), have children later (delaying the arrival of lower-cost, kid-free days) and inherit money later (their parents live longer).

Younger people may not look poor. They have more stuff than ever — more valuable houses, cars and other assets. But they are so much deeper in debt than their parents — student loans, credit cards, mortgages, car loans — that their net worth has shriveled.

What's not clear is whether today's younger people will catch up. Will they reap financial rewards late in life as their parents did?

"Young people have a great future ahead of them, but the rules of wealth creation have changed," says economist Kay Strong of Bowling Green State University in Ohio. She says young people will have to work longer and switch jobs more often than their parents for financial success.

"The baby boomers were the last generation able to ride the old industrial economy that let you hold one job for a long time and retire with a pension," says Strong, 54. "The new economy is going to require people to adapt, hold more jobs over a lifetime and give up the concept that you will retire at 62."

Gary Burtless, a scholar at the Brookings Institution, says the richest and the poorest have improved their standing. The middle class, however, has lost ground, he says.

The poor have been helped by expanded government programs, including the Earned Income Tax Credit, which provided $36 billion to 21 million poor households in 2006. The wealthiest have been helped by lower tax rates on income and capital gains.

"The tax system is a lot less burdensome today on the bottom 25% and the top 10%. It's the middle class that has done less well," Burtless says.

Bernanke, the Federal Reserve chairman, said in February that a snapshot of income today would find greater inequality than 25 years ago. But he said the key question is whether economic mobility — the ability to move up the income ladder — is still strong.

Other factors besides age contribute to income inequality.

President Bush in January cited education's role. "Income inequality is real; it's been rising for more than 25 years," he said. "The reason is clear: We have an economy that increasingly rewards education."

So far, though, the return on education has paid off for older people, but not for younger generations.

The net worth of households headed by a college-educated person ages 55-59 rose to $526,300 in 2004, up from $271,515 in 1989, adjusted for inflation.

This group has enjoyed enormous income gains, too, and had a median annual income of $100,634 in 2004.

By comparison, wealth and income have declined for college-educated people in their late 30s and risen only slightly for college grads in their early 40s. In short, age has mattered more than education in widening the wealth gap in recent years.

That could change as highly educated younger people — who delayed finishing college, entering the workforce and having kids — move deeper into their careers.

Another often-cited contributor to income inequality is race and ethnicity.

From 1995 to 2005, median income soared among Hispanics and income inequality among Hispanics declined, the Census Bureau reports. But this robust trend of upward mobility made the nation more unequal. Why? The growing numbers of Hispanics, who tend to be younger and poorer, may be prospering compared with where their parents started. But they're poorer than white baby boomers entering their most affluent years.

Juan Guillermo Tornoe, 38, an advertising executive in Austin, had an MBA and top newspaper marketing position in Guatemala before moving to the USA in 2002.

"I am 100% sure that the upward mobility of Hispanics will continue," he says. "I've seen it in my work. I've seen it in the data. I've seen it in my own family."

A cousin who arrived 20 years ago has a good job, nice clothes and a nearly paid-off home. "She would be lower-middle class in Guatemala," he says. "Here, she lives a tranquil, prosperous life."

Jeff Barham, 33, who works in human resources in Sterling Heights, Mich., feels confident about his future.

His college debt is paid off, his employer paid for him to get a master's degree, and his wife is a schoolteacher. But he worries whether his generation has enough discipline and opportunity to equal his parents' economic success.

"I have friends with every new gadget out there," he says. "They have a big house, two cars, college loans. I have no idea how they're making it on their incomes."

News of a bursting bubble and increasing foreclosure rates is daily fare in reports of the American real estate market - unless it's New York City's market that's being discussed. Then the picture seems oddly stable; some would even say sunny for the foreseeable future.

The average sale price for a home in the city climbed to $782,000 in the third quarter of 2007, an increase of 20 percent from the same period in 2006, according to figures released yesterday by the Real Estate Board of New York.

"New York City is still considered a cool place to be, and everybody wants a part of it," said Richard Grossman, executive director of downtown sales for Halstead Property. "I have friends from all over country trying to move here."

"Unless banks stops lending [the local real estate market] is not going to fall," he said.

Grossman pointed out a number of factors contributing to the city's seeming immunity from the national real estate crisis.

Foremost, he said, is that the city does not have a high proportion of the subprime loans blamed for many recent foreclosures. Co-op apartment buildings tend not to accept them, and in general New Yorkers make more money than the typical subprime borrower.A weak dollar is also keeping the local market strong by attracting foreign investors in city real estate, Grossman said. Then, there is the age-old factor of supply and demand.

"Even with all the construction going on, you just can't build housing fast enough in this city," he said.

Yesterday's report found prices were highest in Manhattan, where the average home sold for $1.33 million, or around $1,176 per square foot. The average cost of a home went up in every borough except Staten Island, which saw a 2.8 percent drop.

The board's findings is based on data collected by the city and includes all condominimums, co-ops and one- to three-family homes sold in July, August and September. Despite the glowing data, some cautioned against being too optimistic about the market's apparent strength.

Gregory Heym, chief economist with Halstead, pointed out that there is the forecast of a downturn on Wall Street.

"Obviously, we don't know what is going to happen with the Wall Street bonuses," he said. "That is very important not just to real estate but to the whole economy of the city. If Wall Street starts to lay off large groups of workers, the market could turn."

WASHINGTON, Dec. 6 — At least one thing is clear about President Bush’s plan to help people trapped by the mortgage meltdown: it is an industry-led plan, not a government bailout.

Although Mr. Bush unveiled the plan at the White House on Thursday, its terms were set by the mortgage industry and Wall Street firms. The effort is voluntary and it leaves plenty of wiggle room for lenders. Moreover, it would affect only a small number of subprime borrowers.

The plan was the target of criticism from consumer advocates who said its scope was too narrow, and from investment firms, who said it went too far. Others warned that the plan, by letting some stretched homeowners off the hook, could encourage more reckless borrowing in the future.

“The approach announced today is not a silver bullet,” said Treasury Secretary Henry M. Paulson Jr., who hammered out the agreement. “We face a difficult problem for which there is no perfect solution.”

The heart of Mr. Bush’s plan is a cautious attempt to help troubled homeowners by persuading financiers to freeze mortgages at low introductory rates for five years, but without actually forcing the hands of lenders and investors who hold the mortgages.

One of the financial industry’s lead negotiators estimated that at most 20 percent of subprime borrowers whose payments will increase sharply over the next 18 months — 360,000 out of 1.8 million people — would qualify for rapid consideration of a special five-year freeze on interest rates.

The number of people who actually obtain help would be smaller, because each borrower would face tests aimed at weeding out those considered too hopelessly in debt and those who make too much money to justify relief.

In one curious twist, the plan could eliminate many who have good credit scores or managed to improve their credit scores, because the good ratings would be a sign they do not need help.

“Talk about moral hazard,” remarked Representative Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee. “We’ve all told people, don’t go any more deeply into debt. Now we’re saying that people who go more deeply into debt will have an advantage over people who don’t go more deeply into debt.”

The administration’s theory is that there is a “sweet spot” in the market where it makes more financial sense for lenders to offer some relief than it does to foreclose on homeowners.

Most analysts agree there is a sweet spot of some sort. Investors typically lose 40 percent or 50 percent on homes that go into foreclosure, and the cost of shielding borrowers from a big jump in rates can be much less.

“I think there is a sweet spot,” said Bert Ely, a banking consultant in Alexandria, Va. “But I worry that the sweet spot is much smaller than people think it is. And as housing prices continue to decline and debts pile up, I fear the sweet spot will shrink.”

Administration officials estimate about 500,000 subprime borrowers are in danger of losing homes in the next 18 months as their low teaser rates expire and their monthly payments jump by 30 percent or more. Outside analysts warn the number of foreclosures could be much higher.

The Mortgage Bankers Association reported that the number of new foreclosure proceedings hit a record in the third quarter and that the delinquency rate on mortgages climbed to the highest level since 1986. The biggest problem, according to the survey, was in subprime loans, which are typically made at higher interest rates to people with shaky credit records or weak incomes.

But Mr. Paulson and the president’s other top economic advisers have remained staunchly opposed to anything that resembled a government-financed bailout for people who took out foolish mortgages or investors who bought the mortgages.

As a result, administration officials have walked a narrow line. They have held meetings bringing together mortgage-servicing companies and groups representing investors holding mortgages.

Instead of pressuring the industry to come up with specific relief, Mr. Paulson pushed the players to come up with a streamlined approach for deciding when to modify loan terms.

But Tom Deutsch, deputy director of the American Securitization Forum, which represented investment funds in the negotiations, made it clear that any rate freeze would be strictly voluntary and based on what investors decided was in their self-interest.

“This is not a government bailout program,” Mr. Deutsch said. “This is an industry-led framework for providing the best market standards and practices. There is no mandate here.”

President Bush and other top administration officials emphasized that the plan could help as many as 1.2 million subprime borrowers — about two-thirds of all people with subprime loans.

But that estimate covers hundreds of thousands of borrowers who are believed to qualify without any extra help for cheaper conventional mortgages, like those insured by the Federal Housing Administration.

The Greenlining Institute, a housing advocacy group in California that began raising alarms about subprime loans nearly four years ago, estimated that only 12 percent of all subprime borrowers and only 5 percent of minority homeowners would benefit from the rate freeze. The Center for Responsible Lending, a nonprofit group that supports homeownership, said the freeze would help only about 145,000 people.

“This grossly inadequate plan is likely to harm the president’s desire to close the minority homeownership gap and create an ownership society,” said Robert Gnaizda, general counsel for the Greenlining Institute.

Some Wall Street analysts were equally unenthusiastic. “This plan only really amounts to a set of recommendations for lenders that is sure to meet some resistance from investors” in the mortgage-backed securities, wrote Paul Ashworth, an economist at Capital Economics.

Indeed, there were rumblings of rebellion among some institutional investors. “Why would anybody in his right financial mind agree to a five-year price freeze, especially when we’re staring in the face of possible inflation?” asked Roger W. Kirby, managing partner at Kirby McInerney, which has represented investors in class-action lawsuits over securities. “Mr. Paulson has overestimated the generosity of people on Wall Street.”

The company that cooks up credit scores for millions of Americans is changing its recipe -- and that could affect how easily you get credit in the future.

Fair Isaac Corp., maker of the popular FICO credit score used by most lenders, says its new scoring model will do a better job predicting the likelihood of a borrower defaulting on a loan. For one thing, the new model, dubbed FICO 08, will be more forgiving of occasional slips by consumers, but will take a harder line on repeat offenders. Fair Isaac predicts its new system will help lenders reduce default rates on their consumer credit by between 5% and 15%.

The rollout of the new credit-scoring system comes at a time when lenders say they are eager for more-accurate measures of credit risk, in part because of rising loan defaults as subprime mortgages go bad and housing prices fall. And there are signs that delinquencies are creeping into other types of consumer debt, including auto loans, further prompting lenders to tighten up on credit.

The FICO score, which Fair Isaac says is used by 90% of the 100 largest banks, and other similar scores hold sway over the lives of millions of people. Financial institutions use them to determine the granting and pricing of credit, insurance, cellphone usage and, in some cases, employment and utility services. Some consumer groups have raised concerns about whether credit scores are being used properly and whether they are valid measures of credit risk for some groups of consumers, especially minorities and lower-income individuals, says Travis Plunkett, the legislative director for the Consumer Federation of America.

Credit scores, which are calculated using proprietary models, also are criticized for a lack of transparency. "This is a product, per se, but it's a product that has inordinate influence on the financial lives of hundreds of millions of Americans," says Mr. Plunkett. Fair Isaac, based in Minneapolis, says it believes it does a good job of explaining the factors that go into calculating the FICO score and in guiding consumers on how to manage their scores.

Consumers could start seeing the new FICO scores by the spring, though some lenders may take additional time to test the system to see how it works with their business and loan portfolios. Fair Isaac, which last revamped its scoring model earlier this decade, says it is accelerating its FICO 08 rollout, partly in response to lenders' demand for better risk-management tools.

The latest version of the FICO score will largely look and feel the same to consumers and lenders. Scores will still range from 300 to 850 -- the higher the better -- and the model will continue to look at the same factors, including consumers' level of credit indebtedness and payment histories, length of credit histories, number of recent credit openings and inquiries, and the type of credit used, to determine scores.

But the new model will more finely slice and dice the information in consumers' credit files to do a better job of separating the "good risks" from the "bad risks," particularly for subprime borrowers; those with "thin," or young, credit files; or consumers who are actively seeking new credit. "Those are the communities that lenders are most interested in" to determine credit risk, says Craig Watts, spokesman for Fair Isaac.

"Consumers who are low risk will score better with the new FICO version, and consumers who are high risk will score lower," says John Ulzheimer, president of consumer education for Credit.com, a personal-finance Web site. Higher-risk borrowers may find it tougher to get credit, while those with less-risky profiles -- though they may have gotten approved for credit accounts in the past -- will start to get better deals from lenders, he says.

Two people with the same FICO score currently could see their scores diverge under the new system. One possible reason: FICO 08 gives more points to consumers who maintain a variety of credit types, such as credit cards, a mortgage and auto loan, because it shows they can manage payments on different kinds of loans. On the other hand, the new scoring system penalizes to a greater degree borrowers who use a high percentage of their available credit.

FICO 08 also will draw greater distinctions among different borrowers who are at least 90 days late in making a loan payment, known as a serious delinquency. Traditionally, many credit-scoring models grouped subprime consumers into one general category. But Fair Isaac says its new model will give a higher score to a borrower in arrears if they also have a number of other credit accounts in good standing. Conversely, a person's score could drop if he or she has multiple delinquent accounts.

"Overall, more consumers will see their FICO scores go up slightly than will see their scores drop," says Tom Quinn, vice president of global scoring solutions for Fair Isaac.

Despite the new scoring model, consumers still have to make sure the information in their credit reports, which Fair Isaac relies on to come up with its score, is accurate. If consumers feel their FICO score is unfair, they would have to go to the individual credit bureaus, Experian Group Ltd., TransUnion LLC and Equifax Inc., for a copy of their credit report on file and look for any errors or missing information. If there are any, they would have to contact the credit bureau or the financial institutions to dispute those errors.

FICO 08 also aims to curtail the growing business of allowing people to polish their credit by "piggybacking" on someone else's good credit history. In recent years, credit-repair Web sites have sprung up that arrange for subprime consumers to boost their scores by becoming authorized users on accounts held by strangers with better credit. When scoring a consumer, FICO 08 won't take into consideration credit-card accounts for which that person is an authorized user. But the move also will hurt legitimate users: People who give a credit card to a child or a spouse as an authorized user to help boost their credit score.

FICO 08 is likely to face some competition from VantageScore Solutions LLC of Stamford, Conn., a joint venture of the three credit bureaus that was rolled out in 2006. Fair Isaac has sued VantageScore and the three bureaus, accusing them of using unfair and anticompetitive practices to harm the FICO brand. Recently, Equifax linked the suit with the launch of FICO 08. The company has said it wouldn't move forward with FICO 08 and that its relationship with Fair Isaac remains "strained" until the lawsuit is resolved, says David Rubinger, Equifax spokesman. The new FICO model has already been distributed to Experian, which is in the process of implementing it, while TransUnion expects to have the scoring model available for lenders to test during the second quarter of 2008. Fair Isaac says its intention is to provide the formula to all three credit-reporting agencies.

Why home prices could drop 25% more on average before the market finally hits bottom

As Washington policymakers struggle to keep the U.S. out of recession, the swirling confusion over the housing market is making their job a lot tougher. Will American consumers keep shopping or be forced to pull back? Will banks lend freely or be hamstrung by mortgage defaults? What are the best policy options right now? Those and other important questions simply can't be answered without a good idea of whether home prices will rise, flatten out, or keep dropping.

Some experts have begun to suggest that a bottom is in sight. Pali Research analyst Stephen East wrote in a research note to his firm's clients on Jan. 25 that "the sun is not shining very brightly, but at least the worst of the storm has likely passed." With optimism budding, Standard & Poor's beaten-down index of homebuilder stocks soared 49% from Jan. 15 through Jan. 29.

But it's considerably more likely that the storm is still gathering force. On Jan. 30 the government said annual economic growth slowed to just 0.6% in the fourth quarter as home construction plunged at a 24% annual rate. The Standard & Poor's/Case-Shiller 20-city home price index fell 7.7% in November from the year before, the biggest decline since the index was created in 2000.

And that could be just the start. Brace yourself: Home prices could sink an additional 25% over the next two or three years, returning values to their 2000 levels in inflation-adjusted terms. That's even with the Federal Reserve's half-percentage-point rate cut on Jan. 30.

While a 25% decline is unprecedented in modern times, some economists are beginning to talk about it. "We now see potential for another 25% to 30% downside over the next two years," says David A. Rosenberg, North American economist for Merrill Lynch (MER), who until recently had expected a much smaller slide.

Shocking though it might seem, a decline of 25% from here would merely reverse the market's spectacular appreciation during the boom. It would put the national price level right back on its long-term growth trend line, a surprisingly modest 0.4% a year after inflation. There's a recent model for this kind of return to normalcy after the bursting of a financial bubble. The stock market decline that began in 2000 erased most of the gains of the boom of the second half of the 1990s, leaving investors with ordinary-sized returns.

Why might housing prices plunge violently from here? Remember the two powerful forces that pushed them up: lax lending standards and the conviction that housing is a fail-safe investment. Now both are working in reverse, depressing demand for housing faster than homebuilders can rein in supply. By reinstituting safeguards such as down payments and proof of income, lenders have disqualified thousands of potential buyers. And many people who do qualify have lost the desire to buy. "A down market is getting baked into expectations," says Chris Flanagan, head of research in JPMorgan Chase's (JPM) asset-backed securities group. "People say: I'm not buying until prices are lower.'" He predicts prices will fall about 25%, bottoming in 2010.

Nobody can be sure how far prices will decline. Still, if prices drop that much, it could mean big trouble for the U.S. economy, which is already on the brink of recession. It would blow a hole in the balance sheets of banks and households, slicing more than $5 trillion off household wealth. That's roughly the size of the drop in stock market wealth from the peak in early 2000, a big reason for the recession of 2001. Yale economist Robert J. Shiller, a longtime housing bear, points out that a housing decline that started in 1925 and ran until 1932 weakened banks and contributed to the Great Depression, which started in the U.S. in 1929.

MACARONI AND CHEESE

It has become a cliché, but an accurate one, that Americans used their homes as ATMs during the boom years. They lined up for cash-out refis or home-equity loans to turn housing wealth into spending money.

So far, the amount of equity being withdrawn has remained surprisingly strong—$700 billion at an annual rate in the third quarter. But it's bound to dwindle if prices keep falling, giving the economy a further downward push. According to an analysis conducted for BusinessWeek by Zillow.com, the real estate Web site, a further 20% decline in prices nationwide would mean that two-thirds of people who bought in the past year would owe more than their homes would be worth, meaning they couldn't take out cash if they wanted to.

Alesandra Sanchez, who works for the city of Las Vegas, and her husband, Craig Mireles, a project manager for an architect, are living that problem. Their house in Summerlin, Nev., has quickly gone from a money geyser to a drain. The couple raised about $70,000 in cash in 2005 by refinancing less than a year after they bought their home. They put the money toward student loans, medicine for Sanchez's rheumatoid arthritis, and other things. Now the cash is gone and the interest rate has ratcheted up to 11%. Alesandra says the new payment of $4,200 a month "is doablebut it's like eating macaroni and cheese: It doesn't leave room for anything else." No wonder that retail sales fell 0.4% in December, and economists are projecting a sharp slowdown in overall consumer spending this year.

The second shock to the economy from the housing bust will come from the financial sector, which has been weakened by losses on mortgages as well as mortgage-backed securities and more exotic derivatives. Banks borrow so much money to fund their investments that if a loss on some holding reduces their capital by $10, they have to reduce their lending by $100 to avoid exceeding their self-chosen leverage targets, calculates Goldman Sachs (GS) chief U.S. economist Jan Hatzius. He estimates that banks and other financial institutions will suffer about $200 billion in real estate losses and respond by cutting their lending by $2 trillion, or about 5% of total lending. The cutback could be even more extreme if they react to the turmoil by lowering their leverage ratios, he says, rather than keeping them intact. Banks have already begun tightening lending standards. In the third quarter, mortgages were harder to get than at any time in the 17-year history of the Federal Reserve's survey of senior loan officers.

Prices won't fall uniformly, of course. Once-booming cities such as Las Vegas and Miami and weak economies like Detroit are likely to fare worse than Seattle or Charlotte, N.C. The price decline will be smaller if it's stretched out over longer than, say, two years, because inflation will have more time to do some of the job of eroding the real value of homes. Still, if the national average decline is anywhere near 25%, the entire U.S. economy is in for trouble. Keep in mind, says Merrill's Rosenberg, that the relatively puny price decline to date has already pushed home-loan delinquencies to their highest level in 20 years. The plunge in residential construction reduced the economy's annual growth rate by a full percentage point in the third quarter of 2007. A bigger decrease would wipe out even more jobs—carpenters, real estate agents, mortgage brokers, furniture salespeople.

For American consumers, meanwhile, huge losses would almost certainly undermine the long-held premise that homeownership is the most reliable way to build wealth and a middle-class life. "I know you're not supposed to say I told you so,' but I'm at the age where I can do it: Homeownership was oversold," says 67-year-old House Finance Committee Chairman Barney Frank (D-Mass.).

One look at the long-term home price chart tells you all you need to know: Starting in 2000, prices crossed above their trend line and just kept going up. The spike had never happened in modern U.S. history, according to data dating back to 1890 that Shiller painstakingly compiled for the second edition of his book, Irrational Exuberance, in 2005. Back then he predicted a sharp drop in house prices.

Now he says lawyers won't let him publicly forecast home prices because he's involved in preparing the market-sensitive Standard & Poor's/Case-Shiller home price indexes. All he'll say is: "This is a historic turning point."

Optimists point out that the Fed, Congress, and the White House are all committed to keeping housing aloft so it doesn't kill the economy. The Fed reduced the federal funds rate by three quarters of a percentage point on Jan. 22 and followed with a half-point cut on Jan. 30—an extremely rapid move for a major central bank. Homebuilders also are doing their bit to support prices: They've cut production so drastically that even though home sales fell more than expected in December, the backlog of unsold new homes shrank slightly. Douglas Duncan, chief economist of the Mortgage Bankers Assn., predicts existing home prices will slip less than 2% this year before beginning to rebound in 2009.

Pessimists aren't impressed. One of the first high-profile bears on housing, Ian Shepherdson of consulting firm High Frequency Economics, is looking for a 20% decline in prices from their peak but says 40% wouldn't shock him. "We've never been here before, so there's no road map," he says.

There's even uncertainty about where prices are right now, since many would-be sellers are refusing to cut them enough to make a sale. A Harris Interactive (HPOL) survey for Zillow.com in December found that 36% of homeowners thought their homes had increased in value over the past year, vs. 23% who thought they had decreased. That willful optimism translates directly into the record overhang of unsold existing homes: more than 4 million.

For a truer picture of the market, look at sales by banks and builders, which don't have the luxury to wait things out because they have to worry about cash flow. Deutsche Bank (DB), among other banks, has been slashing prices on repossessed homes to get rid of them. In a recent transaction mentioned on BusinessWeek's Hot Property blog, Deutsche Bank sold a house in Woodbridge, Va., in December for $150,000, less than half its last sale price of $315,000 in the spring of 2005. In November, Lennar (LEN), the big builder, sold 11,000 home sites to a joint venture it formed with Morgan Stanley Real Estate for $525 million, 60% below what they were valued on Lennar's books. That's capitulation, and it's likely to occur more often as sellers get the idea that waiting won't solve their problems.

MORTGAGE HURDLES

Plenty of other evidence supports the notion that home prices have further to fall. There's a crisis of confidence in the securitization of mortgages, which pumped up housing demand by giving buyers access to nationwide and even global pools of capital. The loose links in the securitization chain allowed risky loans to be made at low rates. Trust in that system is broken and will not be mended quickly.

Almost the only mortgages being securitized successfully are the ones bought by Fannie Mae (FNM) and Freddie Mac (FRE), the private companies with implicit government backing. They accounted for about 87% of mortgage securitizations in December, vs. fewer than half in 2005 and 2006, according to the publication Inside MBS & ABS and the investment bank UBS (UBS). Subprime lending is nearly shut down, home-equity loans and lines of credit are scarce, and jumbo mortgages (too big for Fannie and Freddie to purchase) command premium rates. A survey of real estate agents found that a third of planned home sales were canceled or delayed last fall because of loan problems.

Even Fannie and Freddie, which style themselves as the last resort of the home buyer, have tightened standards and raised fees. And they remain reluctant to raise funds to buy mortgages if it means lowering returns to shareholders.

Fannie Mae Chief Executive Daniel H. Mudd joked to Wall Street analysts in December that the process of cutting the dividend and selling preferred shares to raise money pained him so much that "I wanted to cut off both my arms and both my legs, and my head, and my kidney."

Cheaper mortgages won't necessarily ride to the rescue, either. Thirty-year conventional fixed-rate mortgages failed to fall after the Fed's two January rate cuts, averaging 5.5% on Jan. 30. Financing remains cut off for subprime borrowers (BusinessWeek, 12/11/07) and for owners whose home equity has dipped too low to qualify for a new loan. Fed rate cuts will ease, but not eliminate, the pain from resets on adjustable-rate loans.

For another bearish view, there's what economists refer to as the Mankiw paper. In 1989, long before working in the White House as chief economic adviser or writing his best-selling textbook, Principles of Economics, Harvard University economist N. Gregory Mankiw co-wrote a paper that was startlingly negative on housing. He and David N. Weil predicted that home prices would decline by 47% after inflation over the next 20 years, based on a shrinking pool of potential first-time buyers and an expectation that baby boomers as a group would spend less on housing as they grew older.

It could be that Mankiw and Weil were not so much wrong as premature. Although boomers have thwarted expectations by adding on rooms and second homes as they age, they won't thwart nature. "At some point, death or illness will cause baby boomers' houses to come onto the market," observed John Krainer, a senior economist at the Federal Reserve Bank of San Francisco, in an in-house publication in 2005. When the huge boomer generation shuffles off, the nation's housing needs will wane. That will create an oversupply unless builders see it coming and reduce construction. Judging from the recent overbuilding binge, though, their forecasting abilities leave a lot to be desired.

NECESSARY EVIL

Observers with a Calvinist streak see a housing crash as not only necessary but also positive. It will force Americans to live within their means, which will enable the U.S. to work off some of its towering debt, says Peter D. Schiff, president of Darien (Conn.) brokerage Euro Pacific Capital, who was early in predicting the crash. In 2005 the share of gross domestic product devoted to residential construction reached the highest since 1950, when the U.S. was racing to house the baby boom generation and make up for the lack of construction during the Depression and World War II. Now, says Schiff, "if there's any construction, it's going to be factories, oil exploration, mines." He takes almost unseemly delight in predicting tougher times ahead: "Americans are going to have their credit cards taken away from them by the lenders. We're going to turn the American economy into a cash economy."

Foreclosure counselors such as Mildred Wilkins foresee similar changes, except in looking back they put more of the blame for the fiasco on builders and lenders and less on borrowers. "We have been fed the illusion that acquiring a home was a magic key to stability, to wealth-building," says Wilkins, who travels the country advising lawyers and others on how to handle foreclosures. Even though she is president and founder of an Indianapolis company called Home Ownership Matters, which promotes responsible ownership, Wilkins says she never believed the "poppycock" that homeownership was a sure path to wealth, calling it a myth foisted on lower-income Americans by politicians serving the builders and bankers.

The sense of betrayal is probably most intense among the working-class families who were supposed to be the greatest beneficiaries of easy access to low-down-payment mortgages. The less-pricey outskirts of expensive cities such as Los Angeles and San Francisco are precisely the areas where the biggest share of recent buyers are underwater on their mortgages. Cindy and Larry Chaffold, who live in the desert east of Los Angeles in Apple Valley, bought a house for $216,000 in 2005 that's now appraised at $190,000. Cindy was ready to hand the keys to the bank until she got her loan modified.

Says Chaffold: "I have been screwed, chewed up, and spit out."

HARKING BACK TO FDR

If home prices really fall an additional 25%, Washington's rescue program is likely to seem seriously inadequate. So far the Bush Administration is pushing two main ideas: FHASecure, which offers new mortgages to certain well-qualified borrowers, and Hope Now, a private-sector program to streamline the modification of unaffordable loans. But FHASecure isn't open to people who are underwater on their mortgages—in other words, those who most need help. And the Hope Now alliance doesn't seem to be coping successfully with the mounting backlog of loan delinquencies. The other big Washington initiative, to crack down on loose lending practices, could be ineffective and even counterproductive, because it's making loan funding less available right when it's needed most.

The next big reform ideas may hark back to President Franklin D. Roosevelt. Many of the housing market's props today—including Fannie Mae and the Federal Housing Administration—were launched during the 1930s. If things get bad enough, say some analysts, it could raise interest in renewing another innovation of the Depression years, the Home Owners' Loan Corp., which lent money directly to hard-pressed borrowers to prevent foreclosure. If enough banks get into trouble, Congress might even create something roughly parallel to the 1980s-era Resolution Trust Corp., which cleared up the savings and loan crisis by shutting down weak thrifts, thus wiping out the investments of the owners, and then selling off their assets to the highest bidders.

And with homeownership no longer seeming like such a sure thing, national housing policy could become more evenhanded toward renters. Congress is weighing the creation of a National Affordable Housing Trust Fund that would build, rehabilitate, and preserve 1.5 million units of housing for the lowest-income families over the next 10 years. The national homeownership rate has already fallen about one percentage point from its peak, to 68.2% in last year's third quarter.

However things unfold, the changes are likely to be wrenching. The bigger the boom, the harder the fall.